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Research Briefs in Economic Policy No. 64

Are Home Buyers Myopic? Evidence from Housing Sales

By
Erica Myers

November 23, 2016

Consumers are often more responsive to changes in purchase price
than to less salient product costs such as shipping and handling
expenses, sales tax, and operating costs of appliances. This type
of consumer inattention has important implications for policy
measures such as taxation, since in order to affect behavior
policies need to target costs to which people pay attention. In
recent years, governments around the world have become interested
in designing successful policy instruments for reducing greenhouse
gas (GHG) emissions. Whether price-based instruments such as taxes
or cap-and-trade programs will be effective crucially depends on
whether consumers are responsive to fuel prices in markets for
energy-using durables.

This policy motivation has prompted researchers to estimate the
responsiveness of purchase price to gasoline price movements for
cars, which account for close to 15 percent of U.S. greenhouse gas
emissions annually. If people lack information about changes in
gasoline prices, or if they are myopic about the resulting changes
in the operating costs of their car, they will underinvest in fuel
economy even under carbon pricing policies. If people are
mis-optimizing in this way, other more traditional policy
instruments, such as corporate average fuel economy (CAFE)
standards may increase welfare relative to a tax alone. However,
the results from this work suggest that car buyers are relatively
attentive to future fuel costs. These findings have important
policy implications, suggesting that it is preferable to address
pollution externalities through gasoline taxes rather than fuel
economy standards, which mandate increases in average fuel economy
over time.

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This paper asks whether consumers are responsive to changes in
energy prices in the housing market. The building sector is another
large source of U.S. greenhouse gas emissions. A growing proportion
of annual emissions, around 40 percent, comes from the residential
and commercial building sectors. As end uses, space heating and
cooling contribute almost as much to U.S. greenhouse gas emissions
annually (13 percent) as personal vehicles (15 percent). In recent
years, consumers spent an average of $272 billion per year on
residential natural gas, electricity, and fuel oil—almost as
much as they did on gasoline and motor oil.

Consumers might be less myopic about gasoline purchases as
opposed to residential fuels. Gasoline is one of the most salient
products that consumers buy. Obtaining information about gasoline
prices is relatively costless, since these are prominently posted
at gas stations, and many people purchase gas one or more times in
a week. In addition, people tend to know how much it would cost to
drive from one place to another by car. Residential fuel costs may
not be as well understood or salient for consumers. Households only
receive energy bills on a monthly basis, making it harder to
translate consumption of particular energy services into costs. In
addition, consumers receive bills where natural gas is combined
with electricity in many areas, potentially muddling individual
effects. Therefore, it is important to investigate whether
consumers are myopic about future energy costs in the housing
market to determine whether taxes alone would be appropriate for
regulating emissions or whether appliance standards and building
codes could improve welfare.

It can be challenging to estimate whether home buyers are
attentive to energy costs. Previous attempts have found that more
efficient homes with lower fuel costs receive premiums in the
housing market. One limitation of this approach is that home
efficiency is not randomly assigned, so that more efficient homes
may be more likely to have renovations or other improvements that
are unobservable to the researcher, but appreciated by home buyers.
Therefore, the observed premium for efficient units may be due to
unobserved differences in homes rather than the causal effect of
energy cost savings.

My study is the first to estimate the effect of plausibly
exogenous variation in energy costs on housing prices. I use
changes in the relative fuel prices of heating oil and natural gas
over time as a source of variation in energy costs. Natural gas is
used to heat homes in most parts of the United States where
substantial heating is required. However, in the northeastern
United States 30 to 40 percent of households still heat with
heating oil. For this study, I focus on the state of Massachusetts,
where there is significant overlap in the geographic and age
distributions of oil-heated homes and gas-heated homes. I compare
the transaction price of oil-heated versus gas-heated homes for the
period 1990-2011, during which there is significant variation in
the relative fuel prices. With two dominant heating fuels I am able
to control for unobserved variation in the macroeconomic
environment. In addition, I observe multiple sales of homes, which
allows me to control for time-invariant characteristics of a home.
As the relative fuel price of a home increases, it should sell at a
discount compared to homes with less expensive fuel.

I find little evidence that home buyers are systematically
“under-valuing” future fuel costs. When the relative
cost of heating goes up by $1 per million British Thermal Units, it
leads to a $1000-$1200 discount in relative housing transaction
price. These results are consistent with full capitalization of the
future benefit to consumers. These results are consistent across
the income distribution, suggesting that rich and poor home buyers
are similarly cognizant of home heating costs. It appears that home
buyers are paying attention not only to whether a home heats with
oil or gas, but the relative prices of those fuels—and
further, how those relative price differences translate into
differences in the value of the future stream of payments.

The finding that home buyers are paying attention to fuel prices
and how those price movements translate into a stream of future
cost differences suggests that fuel costs are well-understood and
salient at the point of sale. This has important implications for
carbon policy since an increasing proportion of U.S. carbon dioxide
emissions come from the residential and commercial buildings
sector. Because home buyers appear to be informed about and are
paying attention to fuel prices, pollution pricing will create
incentives to reduce the amount of energy people choose to consume,
to convert to cleaner heating fuels, and possibly to increase the
efficiency of building shells and appliances.